As the deadline looms for 2012 RRSP deductions, various organizations are offering suggestions to enable Canadians to accumulate wealth for retirement purposes. With continuing low interest rates and financial market indices below the 2008 peak, many Canadians are still feeling the brunt of the 2008-9 financial crisis that led to a decline in financial wealth.

The latest is a proposal by CIBC’s CEO, Gerald McCaughey, to reignite “a culture of savings” by having the federal government offer a voluntary supplementary Canada Pension Plan. Those Canadians wishing to hold more assets in the supplementary CPP will be able to do so as long as they commit to payments lasting up to 40 years.

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The advantage of the CIBC proposal is that it provides defined-benefit arrangements whereby contributors know they will have a certain level of income when they retire until they pass away. By reducing longevity and investment risks, a risk-intolerant contributor is able to shift such risks to someone else, in this case the taxpayers, who will have to back up the voluntary CPP plan if losses are incurred.

Those living longer will get the most benefit from a voluntary CPP investment while those who pass away early lose some built-up savings. While the proposal would not force people to invest in the supplementary CPP, it has its faults, making the idea far less workable.

As is well known, those who are most likely to voluntarily contribute to the plan will expect to live a longer time than the “typical” investor in the plan. This well-known “adverse selection” problem suggests that a voluntary CPP could be quite expensive since a significant part of the population expecting fewer benefits relative to the average will prefer other arrangements that are less costly to them.

A way of trying to separate out different risk-intolerant investors is to offer a menu of benefit options and contribution payments, as in the case of existing annuity plans in the private sector. However, this is not something that CPP does now and it would certainly drive up the cost of administrating the CPP.

Besides, if the voluntary approach works well for a defined-benefit plan offered by a financial intermediary like CPP, why don’t major financial institutions like CIBC offer plans of this sort already? It is hard to see why taxpayers are better able to bear the risk as opposed to financial markets in general, an observation made by French economist Edmond Malinvaud four decades ago.

What makes CPP work cheapest for plan holders is that contributions are mandatory to avoid the adverse selection problem. For this reason, several proposals have been made to expand the CPP, either modestly, or in a big way (the latter being pushed by unions).

A big CPP would, for example, double earnings limits and increase replacement levels with a relatively substantial increase in payroll taxes. While this would provide more defined benefit arrangements to the broad population, it comes with substantial cost. A healthy majority of the population (four-fifths prior to 2009) has had adequate levels of retirement income. Mandatory saving that requires higher payroll taxes to be deducted from paycheques is a significant burden for those already making good saving and investment decisions, such as many younger Canadians who are investing in home equity and raising families.

For this reason, a more surgical approach is needed to help those most without causing undue harm to others. In a paper released Tuesday by the University of Calgary’s School of Public Policy, we argue that CPP could be reformed to enhance benefits that would particularly help Canadians with modest incomes, but without requiring a significant increase in benefits.

For example, we suggest that CPP benefits be increased from 25% to 35% of earnings upon retirement staged over time (for example, the maximum payment would increase from $12,150 to $17,010, using 2013 figures, although the increase would be significantly more in later years, since earnings rise over time). This would be especially important to modest-income Canadians who do not qualify for the Guaranteed Income Supplement.

The increase in CPP benefits would require higher payroll taxes. However, the increase would be minimal if the eligibility age for CPP is increased from 65 to 67 years, beginning in a decade, similar to the recent reform for Old Age Security. It now makes sense to make 67 the norm for retirement in the future, as done in several other countries for social security programs including the United States and many European countries. People are living longer and it is more costly for the broad population to cover retiree benefits.

We also suggest some other regulatory and tax reforms to enable seniors to save better for the future while recognizing that people do live longer. Many proposals are not expensive, such as increasing the eligibility age to allow people to accumulate pension and RRSP wealth on a longer-term basis.

Governments can bring in meaningful reforms to help Canadians have more wealth for retirement years while enjoying longer years of health. It need not be burden on young workers either.
Financial Post

Jack M. Mintz is Palmer Chair, School of Public Policy, University of Calgary and Thomas A. Wilson is Professor of Economics, Emeritus, University of Toronto. Their paper is available at policyschool.ucalgary.ca

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